More rigid bank stress tests set

The Bangko Sentral ng Pilipinas (BSP) said it has adopted an overarching governance standards and risk management expectations on stress testing practices in the banking industry to prepare for events with severe financial impact.

The central bank approved guidelines on the conduct of stress testing exercises as part of the continuing initiatives to further strengthen risk governance and contribute to the sustained safety and soundness of the local banking industry.

The regulator has directed the board of directors of banks particularly domestic systemically important banks or too big to fail banks to consider the results of stress testing exercises in capital and liquidity planning, in setting risk appetite, and in planning for business continuity management.

These expectations are consistent with the earlier issued guidelines on corporate governance under Circular 969.

It added simplified requirements are set out for stand-alone thrift, rural and cooperative banks.

Stress testing is defined as a tool to evaluate the potential effects of specified changes in risk factors on a bank’s financial position under a severe but plausible scenario.

The BSP pointed out banks should develop sound assumptions generally depicting events or scenarios that may result in significant losses and to assess the impact of these scenarios on the bank’s performance or capital and liquidity positions.

For instance, banks may assume 50 percent default in the loan portfolio and assess its impact on capital adequacy ratio (CAR) and level of available funds.

Based on the results of stress testing, the central bank explained banks could adopt proactive measures such as the implementation of capital build up initiatives or enhancement of risk management practices all aimed at improving their resilience in times of actual crisis.

It added banks should employ a combination of different approaches, ranging from simple sensitivity analysis to the more complex tools such as scenario analysis and reverse stress testing.

The regulator has given banks two years to gradually progress from their existing stress testing practices to fully meet the expectations in the new guidelines.

It pointed out the approved guidelines are applicable to all types of banks on solo and consolidated bases.